Clearing key to making derivatives safer: EU

Derivatives pose risks on financial markets that central clearing of contracts would mitigate, the European Commission said on Friday, outlining plans that fall short of more radical U.S. steps.

EU Internal Market Commissioner, Charlie McCreevy, opened an investigation into the sector last October, a month after the collapse of Lehman Brothers, a bank heavily involved in the global $600 trillion off-exchange derivatives market.

McCreevy published his findings and policy proposals on Friday which said standardization of contracts -- a process already underway -- is also needed, as well as the creation of a central data depository to store records of trades.

The plans stop short of more radical steps envisaged by the United States which seek to go beyond centrally clearing over-the-counter trades to shift trading onto exchanges or trading platforms where possible.

In this respect the Commission will further assess the pros and cons of channeling of further trade flow through transparent and efficient trading venues and the appropriate level of transparency -- price, transaction, position -- for the variety of derivative markets trading venues, the Commission's policy document said.

Dealers breathed a sigh of relief that Brussels was holding back from insisting on exchange trading for now.

The International Swaps and Derivatives Association (ISDA) said those exposed to credit risk should be allowed to choose the type of transaction that best suits them.

Removing that flexibility, such as by forcing bilateral participants to trade on an exchange or otherwise limiting the availability of customized risk management solutions, would be a step backwards, ISDA said in a statement.

The bulk of the world's OTC trading is done in London and New York and a less strict regime in the EU could attract business from across the Atlantic, industry experts say.

OTC contracts range from credit default swaps (CDS) to interest rate, equity-linked and commodity contracts. The G20 group of industrialized and emerging countries agreed in April that CDS transactions should be centrally cleared.

Clearing is already commonplace in Europe in OTC products like interest rate swaps and McCreevy obtained a pledge from dealers to start clearing some types of credit default swap contracts in Europe from the end of this month at the latest.

The collapse of Lehman and troubles at insurer AIG and Bear Stearns bank showed regulators how little they knew about the sector.

The opaqueness of the market prevented, on the one hand, other market participants from knowing exactly what the exposures of their counterparties were to these three entities, which resulted in mistrust and in the sudden drying up of liquidity, said the document, obtained by Reuters.

A European central data repository -- widely referred to in the industry as a warehouse for golden copies of trades -- should be looked at, the document added.

The Commission will hold a public hearing on September 25 to discuss the policy proposals, the document said.